Sunday, March 20, 2011
5:30:08 PM EDT

The Ides of March

by
James Brown

It has been an interesting week, that's for sure. This is one year where investors should have heeded the warning, "beware the ides of March!"
The world has been extremely focused on the situation in Japan. The country has been struggling to keep one of its earthquake-damaged nuclear reactors from melting down. Fortunately the situation seems to be improving after they were able to get a power line to the station and start using some of the plant's cooling pumps. It would appear, at this time, the situation is contained or at least getting closer. Yet new headlines of contaminated food and milk in the surrounding area could raise fears that the exposure was a lot worse than the Japanese government disclosed. The Japan story isn't over yet.

Meanwhile the situation in Libya's civil war has done an about face. While the U.N. argued over how and what their assistance to the Libyan rebels might be, Qaddafi was quickly pressing his attack and it looked like he would be able to quash this rebellion through sheer force of arms before the U.N. could make up its mind. When the Arab league finally voted to approve a no-fly zone over Libya, the U.N. followed up with their own vote to enforce a no fly zone to protect Libyan civilians. The moment that headline crossed the wires, Qaddafi announced a ceasefire. Yet secretly he continued to fire artillery at rebel outposts and rebel held cities. French, British, and Canadian war planes started attacking Libyan airspace and tanks while the U.S. fired over 100 tomahawk missiles into the country to take out key anti-aircraft weapons and radars. Qaddafi is calling this a new war of the "crusaders" against an Arab country and promises a long fight. According to the New York Times, the defiant dictator has resorted to using hundreds of human shields, who claim to have volunteered to stay at Qaddafi's compound, to prevent Western nations from bombing it.

The Libyan conflict forces the markets to keep an eye on the global oil supply. Libya's oil output could be significantly damaged for months to come. Meanwhile violence against protestors in other Arab nations is growing. Protestors have been killed in Bahrain, Yemen, and now Syria. These three countries are not big oil producers but investors fear the social "contagion," as it has been called, could spread to Saudi Arabia, the world's pivotal oil producer. It was big news two weeks ago when the markets feared the day of rage protests would ignite a revolution in Saudi but the protestors failed to show up in mass (if at all). Earlier in the month the Saudi king offered about $35 billion in handouts to his people, which is an attempt to keep them pacified. It seems to be working for now.

Oil prices have been volatile the last few weeks and that probably won't change any time soon. This week could see more volatility since the current month futures contract expires on Tuesday. The falling U.S. dollar, which broke down to new 52-week lows, supports rising commodity prices. One of the major stories this past week was a coordinated effort to stop the soaring Japanese Yen. Normally unilateral action by the Bank of Japan to sell yen only has a temporary effect on the currency markets but they are hoping that a coordinated effort by the G7 countries will have more impact. A rising yen would be very damaging for Japan's crucial export businesses.

Closer to home the Federal Reserve announced on Friday that it was allowing some banks to raise their cash dividends and/or stock buyback programs. Previously the 19 banks forced by the feds to do a stress tests could not raise dividends. The new rules allow the banks to raise their payout ratio up to 30% of the company's 2011 earnings. This is a big vote of confidence by the Fed since it means the balance sheets for these banks had improved to a much healthier state. While the announcement was widely expected it still buoyed financial stocks on Friday. Several banks announced higher dividends and several more said they plan to raise dividends later in the year.

Looking at the U.S. market's major indices it was an ugly week. I warned readers a week ago that I expected the S&P 500 to drop toward the 1260-1250 zone. The index fell to 1249 intraday on Wednesday. Stocks saw an oversold bounce off this support level but now broken support at 1300 is new overhead resistance.

There are plenty of traders who want to buy stocks on the dip but there is so much uncertainty the correction may not be over yet. If we see a bearish reversal near the 1300 level it could herald a much deeper decline. I'm still looking at a potential drop toward the 1225 area. Or worse case the 1200 level, which will soon be underpinned by the simple 200-dma. A drop toward 1225 or 1200 could definitely be a new bullish entry point.

Daily chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

Last week I cautioned readers that the NASDAQ composite might see a correction to the 2600 level. Sure enough that is where the index fell to on Wednesday (low 2603). Now the oversold bounce is struggling with the 100-dma as resistance. If the bounce were to continue the NASDAQ could see resistance at 2700 and its 50-dma. I am concerned about the NASDAQ because big cap tech names have not seen a strong bounce. Instead they look vulnerable to more selling. A -10% correction for the NASDAQ would be a drop near the 2550 area. Part of the concern here could be the effect of Japan's earthquake ravaged manufacturing facilities. Investors are worried that the global supply chain could be disrupted for everything from electronic components to automobiles and more.

Daily chart of the NASDAQ Composite index:

Some of the semiconductor stocks could definitely be affected by the supply chain issues related to Japan. The sector fell to new 2 1/2 month lows before bouncing. The SOX could definitely see more of a bounce but there is plenty of resistance overhead.

Daily chart of the SOX semiconductor index:

The small caps might offer a little bit of hope. Unlike its big cap peers the small cap index did not break its 100-dma. While the short-term trend is still down a close over the 800 level (80 level on the IWM) would be encouraging. Of course a reversal near the 80(800) level could mean the correction has farther to go.

Daily chart of the IWM Russell 2000 ETF:

This coming week we have new and existing home sales data. The durable goods orders come out on the 24th. The next Q4 GDP estimate is released on Friday the 25th. We'll also hear the final Michigan consumer sentiment numbers for March. All in all it's kind of a quiet week. The GDP estimate is unlikely to change much. The market's focus will likely be on Japan, Libya, the Mid East, oil futures, and the currency markets.

Short-term the stock market is in no man's land. It has seen a bounce off support but it is nearly in the middle between support and resistance. We don't know yet if last week was a bottom or if the correction has farther to go. Big picture the strength of the U.S. economic recovery is improving and that is bullish for the market. Yet looking ahead I am very concerned about the May-June time frame. Not only will the Federal Reserve's QE2 program expire in June but Spain and Portugal will need to roll over nearly 20 billion euros worth of debt.

The expiration of QE2 in June could be a huge event. Right now the Fed is buying about 70% of the U.S.'s new debt. Who is going to step in and buy that debt when the Fed's program ends? If private money doesn't step in then demand for U.S. bonds will plunge, forcing yields sharply higher, which will push interest rates higher. While no one expects the Fed to do a QE3 they could probably issue some sort of extension on QE2 but that's just kicking the can down the road. In the meantime, assuming the situation in Japan, North Africa, and the Middle East cools down, then the markets will probably return their attention to the debt problems of Europe.

I'm optimistic for April and the first part of May but my crystal ball is pretty hazy on late May and June. The tone of the market could change again if corporate earnings, which start in April, come out strong. A wave of positive earnings guidance and forecasts could do wonders for investor sentiment.